On the Lookout for Lofty Returns?

Low interest rates continue to drive investment dollars into the real estate market, creating a new crop of investors intent on return on investment (ROI) and less focused on managing properties for the long term. With apartment vacancy rates reaching their highest levels in 10 years, loft-style units are attracting attention as a stable investment.

Demand for loft units has remained strong over the past year despite softening rents in the multifamily sector. As low interest rates lure renters of high-end multifamily units to suburban homeownership, lofts are popular with people who are quickly priced out of the housing market.

Lofts stand to benefit from the upswing in the residential market. According to Marcus & Millichap, the multifamily vacancy rate, which currently measures 6.5% nationally, will peak by late 2003, largely due to a reduced volume of completions. As the vacancy rate subsequently drops, the valuation of loft-style properties will rise due to demand.

A Beneficiary of Urban Renewal

The unique characteristics of loft-style living are the primary reason this inventory remains robust despite the market's fluctuations. The physical amenities of loft-style properties — oversized windows, high ceilings, exposed brick — are rare and attract a wide range of tenants, from first-time renters to empty-nesters.

An unexpected benefit of warehouse redevelopment during the technology boom is having a tremendous impact on loft-style properties. In essence, the development of office property in out-of-the-way, hip areas such as former industrial zones revitalized these neighborhoods, breaking down long-held geographic barriers among potential full-time resents.

These neighborhoods are where lofts are most likely to be found. With service and luxury retailers, prospective tenants are looking at these previously out-of-the-way locations. Most importantly, the lofts in these new 24-7, work-live communities are contributing to the ongoing revitalization of formerly abandoned urban areas. For investors, steady renter demand combined with these new neighborhoods are the primary factors driving loft-style property valuations.

Important Considerations

As with any property type, choosing to invest in a loft-style property assumes long-term responsibility and the dedication of time and resources to grow the property's value.

Regardless of whether an investor chooses a third-party manager, rental properties require regular review and are subject to certain financial risks, such as delinquent rent payments and emergency building maintenance.

Because of these risks, many investors in loft-style buildings select condominium properties that offer a one-time profit yield. Condominiums allow investors to avoid the long-term responsibilities associated with management.

Before committing to an investment in a loft property, investors must weigh another important factor when evaluating a loft property deal: how much, in terms of resources, are they willing to set aside to bring the property to market?

In many cases, former warehouse properties and other suitable shells require significant efforts to reposition them for residential use, including navigating the land use and permitting process. Developments from the ground up can cost even more.

In one recent case, a developer purchased a large warehouse property in the Metro Tech section of Brooklyn, N.Y., set for conversion to 62 loft-style rental units by mid-2004. With nearby subway access, 12- to 15-foot ceilings and new windows, the property is an excellent example of high-quality space positioned to benefit from strong fundamentals. With permits and architectural plans in place, this type of repositioning involved far less risk and financial exposure than it would otherwise.

What the Future Holds

Although the jobless recovery has negatively affected the residential market as a whole, investors in loft-style residential inventory have found that demand remains robust in most cases. For high-quality properties with great amenities, developers are signing pre-lease agreements before construction is finished. And we are beginning to see loft-style developments push outward geographically, entering traditionally suburban areas.

Investors looking to park their money in a safe harbor will continue to consider real estate — specifically loft property investments — one of the most reliable financial vehicles available.

M. Luca Capin is president of New York-based Capin & Associates, a full-service real estate firm.

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